Real World Climate Scenarios (RWCS) Roundtable held on 4 May 2022

Notes from the meeting, and some thoughts for the future

Background

In the last few months of 2021, Mark Cliffe, Willemijn Verdegaal and Mike Clark started a
conversation about the inadequacy of the publicly available climate reference scenarios. A good
start, but no more than that. This led to organising a roundtable, the Real World Climate Scenarios
(RWCS) Roundtable. Held on May 4th, invitations were extended to a selected group of individuals
who spent 90 minutes discussing the key issues and possible ways forward.

This note summaries the points made, and offers tentative comments on how Mark, Willemijn and
Mike are thinking of progressing this initiative. Input is always welcome, and at any time.

Introduction

Mark introduced the roundtable, stating that his perspective was a ‘real world’ one, and how to
move on to practical implementation of net zero strategies. We are all now entering the phase of
‘having to get stuff done’. A commitment to net zero implies action now. Interim target setting leads
to annual carbon reduction in the real economy. How are we going to do this (reduce emissions)
year by year? Why and what are clear. Now the How? becomes the challenge.

How do we start to operationalize real world climate scenarios?

Initial Consensus

There was helpful consensus (though not necessarily unanimity) around the following points:

• The current economic climate scenario modelling is not fit for purpose. And there is even a
significant degree of consensus amongst leading climate modellers on this point
• Narratives (scenarios) are key, modelling will follow. Narratives make explicit assumptions
about non-modellable drivers like politics.
• We need to focus, a much greater focus, on short time horizons. Covid, Ukraine, elections.
Five years seems generally appropriate, aligning broadly with business strategy planning
horizons. Because volatile outcomes cannot readily be “modelled”, they tend to be ignored.
• We need to separate the objectives of transition planning from stress testing. They require
different approaches, though there may be overlaps.
• The Covid and Russia/Ukraine shocks illuminate the need for greater attention to
“discontinuities” in scenario modelling work. Volatility is particularly important in
accelerating change and widening the range of outcomes in the short as well as long term.
 • There is often inappropriate quantification when a more qualitative approach would be
beneficial.
• Many organisations are committed to Net Zero, yet they are not committed to getting there!
• We need a greater focus on possible pathways, and a greater understanding of the
dispersion of those pathways. Tail risks, tipping points, are under-appreciated.
• Vuca (volatility, uncertainty, complexity and ambiguity) is more prevalent than is
acknowledged.
• There is no agreement among economists about the “right” models.
• We need to shorten time horizons, and ensure there is enough focus on transition risk,
which lurks in the short term

Other Points and the Evolving Discussion

Other points made during the roundtable were

• One participant had delivered a scenario to a client in 2014 which included a Russian
invasion of Ukraine. We can get better at considering unlikely but plausible outcomes.
• Many mature UK DB pension funds are looking to wind-up/buy-out in the next 5-10 years so
see the climate challenge as “not arising on their watch”. This suggests greater recognition is
needed by pension funds of a potential discontinuity (as in the PRI’s IPR).
• Competent capacity is weak, and needs to be nurtured and to grow.
• Greater pressure by governments on investors to invest in a climate-aligned way tends to
increase demand for the supply of suitable investments, making them expensive. Should
government recognise the need for improved policy to tilt the risk/return framing?
• Scenarios need to highlight the behaviour of prices and volumes to show market as well as
climate outcomes. Moreover, price parity is an important tipping point for adoption of green
solutions.
• Was the focus of this initiative on companies and individual organisations, or on
policymakers and regulators?
• Policymakers/governments and financial regulators can differ in their approaches to
risk/opportunity.
• Geopolitical risks are often under-recognised. Yes, they are hard to model, but scenarios are
quite capable of capturing them qualitatively.
• There is a need for powerful narratives, with deeper insights, delivered by advocates seeking
to change hearts and minds, and thus decision making.
• Let’s focus on empirical trends in technology deployment
• The industry is being forced to use quantified tools without really understanding their
limitations.
• Decision-makers need to consult different types of models before making decisions,
especially equilibrium and non-equilibrium models as they lead to very different
conclusions.
• Important to challenge ‘bonkers’ assumptions. (The term bonkers was later given academic
credibility!). Too great a focus on quantification may be spurious, give false comfort and may
stand in the way of actions like changing asset allocation, considering deforestation etc.
 • How do we shift the needle to something that is wider? How can we encourage adoption of
a more systemic approach/systems thinking? We need to get away – at speed - from the
linear and siloed approaches currently being used.
• Introduce a greater focus on qualitative modelling. Need to look at market and government
responses, which are very hard to quantify. Should expand scenarios to qualitative &
behavior narratives. The problem is much bigger than what models say.
• Financial and non-financial targets need to match up. Focus now on which temperature
outcome will be most likely, and less on the path to that. What do you want to see, and
what are your measurements and targets?
• The models used now in NGFS/BECS were not designed for climate stress testing. They are
completely inadequate for stress testing. How can we get more relevant scenarios? Climate
outcomes won’t happen in isolation. There is inadequate consideration of how climate
effects are going to interact with the real world, the feedbacks, the transmission channels.
Therefore, we are underestimating the risks. Also think about objectives. What is this
particular scenario for? Scenarios used for transition planning will likely need to be different
to those used in stress tests.
• In development banks the scenarios used are especially poor. Are scenario discussions
broadly seen as a first world issue?
• Need to estimate more accurately physical risk and tail risks associated with that. Also, more
insight needed on technology costs and rate of transition. Need for better understanding of
the interactions between macro-models and micro-economic models used at financial
institutions. Must link quantified analytics with qualitative views from experts in the field.
• Geopolitical risk interacts with climate risk. Need to consider how each can drive the other.
Politics is important.

As the discussion evolved, we considered: What do we need scenarios to do? What are we trying to
achieve? What are the use cases?

• Drivers of transition in the short term (markets, prices, technology, policy) are crucial. Goals
should be about implementing net-zero commitments.
• We should facilitate transition planning. Consider the excellent work of EEIST, and
complexity economics. We can help people to be less scared, to assume success, and that
can lead them to a better (less constrained) way of thinking about the problem. Focus less
on Allocation Economics, more on Formation Economics.
• Need to facilitate the alignment of both systemic success as well as organization-specific
success. Let us recognize we all have a stake in (a responsibility to) the systemic success –
even if at first that seems not aligned with individual organization success.
• Need to support people with what they need to do, their implementation tasks.
• Pension fund focus is more on stress tests – looking at a wider tail of 10% of risks, not ½%.
• The regulatory focus tends to be on stress tests – we need a wider perspective. Short term
horizons should not undermine strong action in favour of long-term risk management.
• Scenarios should help organizations achieve business continuity.
• We need more information on the liability/health side. Can be very impactful. Also, P&C
actuaries are probably over-optimistic on our/their ability to manage risk using regular risk
management tools.
• Long-term and short-term goals need to be consistent, even if the drivers differ. Need to be
conflated into one coherent scenario
• Public reference scenarios should make a global transition to net zero credible. This is not
the case at present, net zero is currently viewed as not credible. We probably have to mix
transition and physical risk scenarios in order to get a more realistic (real world!) scenario.
• Make a distinction between stress testing and scenario analysis. Scenario analysis → the
most credible futures, highlighting options as they unfold.
• The three main stakeholders are businesses, financial regulators and policymakers.
• Loss and Damage angle: are central banks and financial supervisors constrained by their
political masters? Quite likely.
• Why is not everyone aligned around net zero transition? Probably because of up-front costs.
Economic actors do not see second/third round multiplication/spillover impacts that show
system-positive impacts. So, are we looking at the best economic models? We need to build
agreement on the economic fundamentals. Then move forward with transition plans for the
system as a whole.
• People are committed to net zero, but just not committed on getting there! They don’t like
any of the pathways. There are lots of good models, but there is an issue of groupthink
around trying to second guess what governments might do. Key issue is how to change the
politics around the use of models.
• We discussed two basic approaches: (1) shift the official narratives to drive private action, or
(2) produce realistic narratives for the private sector that also contemplate systemic failure
to reach net zero. These are not mutually exclusive, but it is an important distinction. On
balance, it was agreed to prioritise (1).

• **Principal objective of this initiative was agreed: SHIFT OFFICIAL/PUBLIC REFERENCE

SCENARIOS TO MOVE OFFICAL THINKING, so that private actors will then follow **

• We know what climate risks are, but there are not enough opportunities to invest in. Need
to deliver more investment opportunities. Scenarios should facilitate an investible pipeline. .
Part of the problem is that official forecasters have not appreciated the growth benefits
that will arise from the transition.
• We need to recognize explicitly that volatility is going to increase (and/or that we
acknowledge volatility more readily). Uncertainty (even if we cannot measure it) is bigger
than is realized. Tipping points are under-appreciated. Scenarios should bring home that
early action gives much more credible/secure results, and drives a reduction of
uncertainty. Current scenarios fail to capture this, and lead to complacency.
• Climate should not be looked at too narrowly. Nature-related risks e.g. loss of
food/conflict/mass migration/disease are big transmission channels too.
• It is impossible to show future outcomes reliably because risks/volatility/uncertainty
increases exponentially. Should we therefore focus primarily on short term transition
scenarios?
• Is net zero a net win or not? It is a net win.
• https://assets.lloyds.com/assets/pdf-food-system-shock-june-2015/1/pdf-food-system-
shock-june-2015.pdf
 • https://www.inet.ox.ac.uk/publications/no-2021-01-empirically-grounded-technology-
forecasts-and-the-energy-transition/
• Where growth continues, with high confidence we can predict costs will fall and solutions
get opened up. The story of rapid technological and political change does go together.
Scenarios need to highlight the behaviour of prices and volumes to show market as well as
climate outcomes. Price parity is an important tipping point for adoption of green solutions.
• Need to construct a positive future scenario that creates opportunities as well as reduces
risks. Paint a picture of collective human prosperity. Climate change coming under control,
restore nature, economic prosperity. This is the way to a better future, and this is how we
get there. Needs to be a narrative politicians can get behind. But needs to be concrete and
credible!
• Agreement on need for narrative improvement. The current narratives are not positive.
• We need to show what “good” scenarios look like. Perhaps we can craft “10 tests”.
• So perhaps concentrate on making short term, transition focused, prosperity focused
narrative
• Be careful to be inclusive – multi-national dimension. China/India

How are public reference scenarios falling short?

• See above. And public scenarios can easily suffer from political correctness.
• They do not adequately address systemic risk, feedbacks, and underestimate physical risk
• They are not good for stress-testing.
• Are they sufficiently clear on what they are aiming to do?
• Need to pin down the most material omissions and illustrate/evidence why these omissions
are material for a particular use case.
• Shorter horizons grab people’s attention.
• Capacity building issue → do the people developing these scenarios have enough breadth of
expertise? Many of those involved in this initiative (and as it expands) can probably assist.
• https://openknowledge.worldbank.org/handle/10986/37041: World Bank paper identifying
the challenges with physical risk scenarios by NGFS and others, and proposing a framework
for developing decision-relevant scenarios.
• An article in The Actuary about the macro modelling:
https://www.theactuary.com/2022/03/01/under-bonnet-different-economic-engines-drive-
climate-change-scenario-models
• The CGFI (Centre for Greening Finance and Investment) at the Oxford Smith School is about
to launch a survey for financial institutions including asking about key material
risks/opportunities missing from scenarios (with a focus on CBES)

Further thoughts

• Can people help identify existing initiatives? Can we engage with them to leverage our work,
and vice versa? Use our networks.
• Who are the key influencers in this world? How can we engage with them? Carney, Stiglitz,
Stern etc. Plus CEOs. A global conversation. Engage with organisations (e.g. BIS, OMFIF, IIF).
The media. The political dimensions of engagement.
• Should we create a LinkedIn group? Post relevant material there. Very senior people cannot
join that. Perhaps a WhatsApp group would be better?
 • Let’s not waste too much time on paper production but concentrate on the influence
strategy.

Conclusion and Next Steps

• Issue this Note to participants in draft for comment and then finalise swiftly
• Issue this Note in final form to participants. Encourage them to use it in their networks as
appropriate.
• Encourage feedback to Mark, Willemijn and Mike on how to build on this initial effort
• Mark, Willemijn and Mike plan to meet in June to consider further Next Steps. That meeting
is likely to result in a further Note which will be shared with the original Roundtable
participants, and others.

Attendees

Sam Butler-Sloss, Mike Clark, Mark Cliffe, Janos Hidi, Aled Jones, Claire Jones, Derek Leatherdale,
Nicola Ranger, Philippe Smit, Sandy Trust, Willemijn Verdegaal, Roberta Pierfederici, Rupert Way,
Peter Young

Appendix: Briefing Note issued before the Roundtable

This Briefing Note was written by Mark Cliffe, reviewed by Willemijn Verdegaal and Mike Clark, and
issued to participants before the Roundtable to stimulate discussion.

V1
Real World Climate Scenarios

Introduction

Scenario analysis is designed to aid decision-making in uncertain environments. Policy-makers and

regulators have embraced it as a key technique for addressing the challenges of climate change.
Following the lead of the Intergovernmental Panel on Climate Change (IPCC), financial regulators
have used scenarios to examine alternative climate and climate policy pathways to highlight the
need for action. For business as well as policy makers, scenarios help to identify risks and
opportunities arising from climate change.

Up until now, the focus has been largely on long term regulatory driven scenarios highlighting the
global systemic challenges posed by global warming. But regulators have also been calling for
financial institutions and corporations to use short and medium term scenarios to embed climate
risk analysis into all of their decision-making.
These calls have been given added urgency by the need to execute transition plans to meet recent
commitments to Net Zero green house gas emissions. Moreover, the latest round of IPCC reports
have highlighted the evidence that climate change is accelerating.

This shift towards shorter horizons and business applications is crucial, because it should switch the
focus away from the climate itself to the vicissitudes of politics, markets and extreme weather
events. This switch in focus should also be reinforced by the fact that having taken the goal of Net
Zero on board, the need is less to consider alternative emissions and climate paths, but rather the
variety of routes to Net Zero.

At the same time, the limitations of current official scenarios and methodologies (notably from the
NGFS) are becoming increasingly apparent. They are failing to capture key aspects of the real world,
including acute physical risk, politics and policy, unemployment, finance, asset prices, volatility,
tipping points, path dependency and complex feedback loops.

These omissions lead to implausible and partial narratives, which limit user engagement and divert
modelers’ attention for critical variables. In the process, they limit their practical usefulness for both
policy making and business decisions. Worryingly, these omissions mean that the resulting scenarios
inadvertently understate the potential range of outcomes.

It is sadly ironic that the omission of crucial aspects of the real world is often excused on the basis of
modelling or data limitations. The pervasive use of ‘DICE’ general equilibrium models compounds
the unreality of the scenarios in general use, since they result in implausibly smooth adjustment
processes and proxy climate policy largely through carbon pricing, the progress on which is
depressingly slow. In the process, such models typically lead to implausibly low estimates both on
the economic damage of climate change or on the potential benefits of action.

Another factor is that policy makers and business alike approach climate scenarios with both
conservatism and ‘political correctness’, making them reluctant to include subjective or controversial
drivers of change. In particular, there is a reluctance to make assumptions about much needed
political or policy changes, or future technological progress. Scenario narratives rarely explore the
implications of plausible assumptions about hard to quantify drivers of change such as politics and
social change.

As a result, there is an urgent need to develop scenarios that better capture critical features of the
real world and assess the factors that will drive action against climate change. The forthcoming Real
World Climate Scenarios roundtable is intended to be a modest step towards addressing that need.

This note is offered to help participants to prepare for the roundtable by proposing some principles
and processes designed to help generate more realistic and action-orientated climate scenarios.

The first section, ‘Key Qualities of Real World Scenarios’ highlights the need for scenarios that are
need to be relevant, plausible, illuminating, provocative and actionable. Given the urgency, this
means that there is a particular need for shorter term scenarios that address the key drivers of
climate action.

The second section,‘ The Scenario Construction Process’, emphasises the need for a thorough
analysis of the scenario drivers in order to develop realistic scenario narratives, which should include
assumptions about key drivers, not least political, that are often hard to quantify or model. It
includes an example of a classic 2x2 scenario matrix, which features policy intervention and market
dynamism as its two main driving dimensions.
The note concludes with an edited version of a blogpost entitled ‘Climate Shock: time for more
stressful tests on banks’, which suggests how central banks could address some of the limitations of
the current approach to risk scenarios and inject more urgency into the banks’ action on climate.

1. Key Qualities of Real World Scenarios

Real World Scenarios need to be relevant, plausible, illuminating, provocative and actionable. For
many practical purposes, official climate scenarios fail to meet these criteria:

1. relevant - to the organisation, its context and the purpose at hand, and the type and time horizon
of decisions; for climate change, the need for action is urgent, so short term horizons are crucial. It is
important to focus on what is material to the user, and issues that they control. Unlike policy-
makers, individual firms do not control systemic risk (unless they are monopolists!). Businesses find
it hard to relate to 30 year horizons, so scenarios should highlight more immediate – and urgently
needed - practical steps that they can take, including strategies, policies and investments to address
the risks and opportunities raised.

2. plausible – based on realistic assumptions, that embrace all the essential drivers in terms of
impact and uncertainty. There should be logical and internally consistent narratives that captures
the appropriate dynamics of the scenario drivers. In the case of climate change, many of them are
subject to ‘VUCA’: volatility, uncertainty, complexity and ambiguity. This makes them hard to model,
but they should covered by explicit assumptions in the scenario narratives. Examples include the
volatility of energy prices and complex interactions between politics, policy and technology. Official
climate scenarios largely ignore these issues.

3. illuminating – increasing insight on the drivers of change. While many climate change issues are
subject to VUCA there are some things we can be more confident of, even if only in terms of
direction. For scenario analysis, identifying such ‘predetermineds’, such as population growth or
chronic physical risk (at least in the short term), is invaluable in narrowing the scope of analysis. The
focus should be on adding new insights. For example, while we know that renewables have to
replace fossil fuels over next 30 years, what do the scenarios tell us about price risks over the next
three years?

Scenarios should also shed light on the complex dynamics and interlinkages between their drivers. In
the case of climate risk there are often positive feedbacks and tipping points in both physical and
non-physical processes which may accelerate change.

4. provocative - wide enough range of paths and outcomes to avoid complacency and deter
groupthink. The scenario set should be rich enough to discourage users from relying on a single base
case or simple average of scenario outcomes. Scenarios should challenge the users’ assumptions
about the future. Exploring a range of alternative scenarios allows users to identify potential risks
and plan how to counteract or mitigate their impact. They may also reveal multiple pathways and
triggers that lead to similar outcomes. In the case of climate, the goal of Net Zero GHG emissions
may be reached by many different routes.

5. actionable – provoking positive change in matters that the user can address. The scenarios should
not be unduly detailed or complex, and avoid spurious quantification. They should also recognise
path dependency and binary shifts, notably in government policy. Common outcomes across
scenarios may yield ‘no regrets’ or ‘win win’ actions. Equally scenarios should seek to alert users to
unintended consequences, for example disinvestment strategies may trigger the risk that you are
trying to avoid. In the face of radical uncertainty, the precautionary principle may call for simple
heuristics that limit or eliminate exposure to tail risks.

2. The Scenario Construction Process

1. Define the objective

What problem are you trying to solve? What action are you expecting to take? Over what time
horizon?
2. Identify external drivers.
Develop a comprehensive list of relevant drivers, drawn from politics and policy, the environment,
economics, technology, and society.
3. Assess the drivers
Build a useable framework based on the impact, uncertainty, interlinkages and ranges of the key
drivers
4. Define the Scenarios
Identify the most important drivers, clustering other related drivers based on their interlinkages (see
example below).
5. Develop the Scenario Narratives
Engaging stories for each scenario should explain how the key drivers interact and affect the
organisation’s context.
6. Quantify the scenarios
Where possible calibrate the scenarios with quantitative modelling or develop methods and metrics
for qualitative variables.
7. Embed into decision-making
Develop a scenario thinking culture throughout the organisation’s strategy, planning and operations.
3. Climate Shock: time for more stressful tests on banks*

Extreme weather events are becoming bigger and more frequent

There is no doubt that the central banks, supervisors and regulators recognise the urgency of climate
change. This is why they are conducting stress tests on the financial risks that it poses to the banks
and other financial institutions. Sadly, the signs are that the scenarios that they have so far provided
for this purpose will not be stressful or shocking enough to make much difference the financial
institutions’ behaviour. Perhaps inadvertently, they risk fostering complacency.

In an article for Environmental Affairs, I note that despite the central banks’ humility about their
current modelling, their scenarios suggest that climate risk will make little difference to growth or
financial losses even on a 30 year horizon.

In the ECB’s case, the cumulative total difference in GDP between their business-as-usual ‘hot house’
scenario and an orderly policy ‘Net Zero’ scenario is barely 3%. This is despite escalating physical
risks and the dramatic transformation in the economy that decarbonisation will entail. This modest
range of variation is against the basic essence of the scenario method, which is to explore a wide
enough range of possibilities to provide strategic insights.

If the central banks wish to inject the needed urgency into the financial institutions’ embrace of
climate risk the next phases of their stress testing exercises will have to rise to the challenge set by
the BIS for an ‘epistemological rupture’. There are four ingredients that could feed into the rethink
required; their scenarios should:

1. Focus on shorter time horizons in line with traditional solvency stress tests and the planning
horizons of the financial institutions. Most of them are already signed up to being ‘Net Zero’ by
2050, so the challenge is to operationalise this now and to recognise that the financial
risks and opportunities are far larger and more immediate than the central bank scenarios suggest.
The ECB’s announcement that this year’s stress test will incorporate policy and weather shocks in
2022 is therefore a welcome step forward.

2. Stop ignoring or downplaying crucial risks. Extreme weather events, political disruptions, policy
shifts, financial markets, behavioural and technological change are all aspects that are difficult to
calibrate and model. But failing to account for them severely reduces the realism and useful of the
scenarios for stress testing purposes.

3. Recognise that non-linear dynamics will accelerate change, for good or ill, making the likelihood
of extreme outcomes far more likely. The central banks’ models yield smooth orderly changes and
fail to capture the risk that the climate may breach thresholds beyond which damages may
accelerate and become irreversible or existential. Socio-political disruptions, policy shifts and market
spikes and crashes could all feature in more illuminating short term scenarios.

4. Adopt a systemic approach to factor in the complex interactions between the drivers and impacts
of climate change. Earth systems and the economic, financial, political and social systems are
interdependent in a way that can lead to powerful feedbacks. This adds layers of uncertainty which
argues for embracing the ‘precautionary principle’ by making assumptions that result in a broader
range of outcomes.

A prime illustration of the problem is that the central banks’ scenarios start from the same economic
growth baseline, even though it is obvious that different growth rates and cycles would dramatically
alter the evolution of climate risks. What makes this particularly odd is that macroeconomic shocks
are at the heart of traditional stress testing exercises.

But the scenario method provides room to develop plausible narratives to address these
complexities. The pandemic has provided a timely lesson in how nature can trigger rapid changes in
human behaviour, whether it be politics and policy, markets and innovation, or social norms and
consumer behaviour. In the case of climate change, official forecasts continue to underplay the fact
that the costs of renewables are falling, partly through policy support, in a way that is triggering
tipping points in business and consumer demand.
On the flipside, the central banks also understate how policy inertia or missteps could crystallise
longer term financial risks from stranded fossil fuel assets and labour well before 2030, let alone
2050. It is time to inject some real stress into their climate stress tests.

* This is an edited version of the following blogpost: Climate Shock: time for more stressful tests
on banks

Mark Cliffe

END